Activity Based Costing Learning Objectives

Transcription

1 Activity Based Costing 5 Learning Objectives After studying this chapter, you should be able to Discuss the limitations of using only unit-based drivers to assign costs. Provide a detailed description of activity-based product costing Explain how homogeneous cost pools can be used to reduce the number of activity rates. Describe activity-based system concepts including an ABC relational database and ABC software. Sec 1_Ch-05_Activity Based Costing.indd 5.1 1/12/2011 3:51:55 PM

2 5.2 Problems and Solutions: Advanced Management Accounting Introduction INTRODUCTORY THEORY Activity based costing system is a cost accounting system that uses both unit and non-unit based cost drivers to assign costs to cost objects by first tracing costs to activities and then tracing costs from activities to products. Definitions of Important Terms Cost Object: Cost object is any item such as products, departments, projects, activities, and so on, for which costs are measured and assigned. Cost Driver: Cost driver is a factor that causes a change in resource usage, activity usage, costs and revenues. Resource Cost Driver: It is a factor that measures the demand placed on resources by activities and is used to assign the cost of resources to activities. Activity Cost Driver: It measures the demands that cost objects place on activities. It is used to assign activity cost to cost objects. Stages in Activity Based Costing 1. Identify, define, and classify activities and key attributes. 2. Assign the cost of resources to activities. 3. Assign the cost of secondary activities to primary activities. 4. Identify cost objects and specify the amount of each activity consumed by specific cost objects. 5. Calculate primary activity rate. 6. Assign activity costs to cost objects. Classifying Activities To help identify activity driver and enhance the management of activities, activities are often classified into one of the following four general activity categories: (i) Unit level activities (ii) Batch level activities (iii) Product level activities (iv) Facility level activities Purpose of ABC ABC is used particularly in organisations where: (i) Production overheads are high in relation to direct costs. (ii) There is a great diversity in the product range. (iii) Product use very different amounts of overhead resources. (iv) Overheads are significantly non unit level overheads. Activity Based Costing System Installation and Operation The Motions for Pursuing an ABC Implementation: (i) Removal of product under costing and overcosting for costing accuracy. (ii) For identification and elimination of non value adding activities. (iii) Accurate cost information for decision making. Distinct Practical Stages in the ABC Implementation: 1. Staff training 2. Process specification 3. Activity definition 4. Activity driver selection 5. Costing Sec 1_Ch-05_Activity Based Costing.indd 5.2 1/12/2011 3:51:57 PM

3 Activity Based Costing 5.3 Activity Based Cost Management Activity based cost management is a system wide, integrated approach that focuses management s attention on activities with the objective of improving customer value and profit achieved by providing this value. ABC is the major source of information for activity based management. ABM Model Systems Planning Identify, Define, and Classify Activities PVA ABC Assess Value Content of Activities Assign Resource Cost to Activities Define Root Causes of Each Activity Reduce Costs Improve Decisions Identify Cost Objects and Activity Drivers Establish Activity Performance Measures Calculate Activity Rates Search for Improvement Opportunities Increase Profitability Assign Costs to Cost Objects Process Value Analysis Process value analysis is fundamental to activity based responsibility accounting, focusing on accountability for activities rather than costs, and emphasising the maximisation of system wide performance instead of individual performance. Process value analysis moves activity management from a conceptual basis to an operational basis. Process value analysis is concerned with: 1. Driver analysis It is effort expended to identify those factors that are root causes of activity costs. 2. Activity analysis Activity analysis is the process of identifying, describing, and evaluating the activities that an organisation performs. Activity analysis should produce four outcomes: (i) What activities are performed. (ii) How many people perform the activities. (iii) The time and resources required to perform the activities. (iv) Assessment of the value of the activities to the organisation, including a recommendation to select and keep only those that add value. Sec 1_Ch-05_Activity Based Costing.indd 5.3 1/12/2011 3:51:57 PM

4 5.4 Problems and Solutions: Advanced Management Accounting Activities Value added activities Activities necessary to remain in the business Not valued by internal or external customers Contributes to customer value Non value added activities There are unnecessary activities Fails to produce a change in state Helps to meet organisational needs Points to Remember In ABC we have 2 Steps: Prepare a Statement of Cost Pool Prepare Statement of Cost / Statement of Overhead cost as per requirement of question. Statement of Cost (ABC Technique) Product A Rs B Rs C Rs Total Rs Material (identifi ed) Labour (identifi ed) XX XX XX XX Overhead XX XX XX XX XX XX XX XX Set up Cost XX XX XX XX COST POOL Overheads Amount Activity No. of Cost Rs. activity activity Machine Rent XX No. of times Usage XX XX purchase XX usage Setup Cost XX No. of Setup/Setup hour XX XX set up Stores XX No. of Required XX XX slip XX Slip/Material Cost/Qty. Inspection Cost XX No. of Set up XX XX Production Rent Packing Charges XX No. of livery XX Others XX Method of absorption XX Cost Driver Cost Pool means a statement in which all the overheads to be analysed into two parts: Activity oriented over heads. Non activity oriented overheads so that all the overheads called be identifi ed with the product can the basis of their respective activities. Cost Driver means the allocation base with the application of which the overheads can be identifi ed with the product. Direct Material: 1: Directing traced with production 2: Final quantity increase. 3: Integral and major part. Indirect material: Used to produced fi nished Good with raw material. Sec 1_Ch-05_Activity Based Costing.indd 5.4 1/12/2011 3:51:57 PM

5 Activity Based Costing 5.5 Points to Remember ABM is a currently used for a variety of business applications such as: Cost reduction: ABM can reduce costs in four ways: (a) Activity elimination (b) Activity selection (c) Activity reduction (d) Activity sharing Performance measurement: It measures how well an activity was performed and the results achieved. Measures of activity performance are both fi nancial and non fi nancial and center on three major dimensions: (a) effi ciency, (b) quality, and (c) time. Business process re-engineering: It refers to the performance of a process in a radical way with the objectives of achieving dramatic improvements in response time, quality and effi ciency. Benchmarking: Benchmarking is complimentary to ABM and it can be used as a search mechanism to identify opportunities for improvement. Benchmarking uses best practices found within and outside the organisation as the standard for improving activity performance. Activity based budgeting: Activity based budgeting analyses the resource input or cost for each activity. It provides a framework for estimating the amount of resources required in accordance with budgeted level of activity. Question 1: XYZ Plc manufactures four products, namely A, B, C and D, using the same plant and processes. The following information relates to a production period. Product Volume Material cost per unit Direct labour per unit Machine time per unit Labour cost per unit A 500 $5 ½ hour ¼ hour $3 B 5,000 $5 ½ hour ¼ hour $3 C 6,00 $16 2 hour 1 hour $12 D 7,000 $17 2½ hours 1½ hours $9 Total production overhead recorded by the cost accounting system is analysed under the following headlines Factory overhead applicable to machine oriented activity is $ 37,749. Set-up costs are $4250. The cost of ordering materials is $1920 Handling materials- $7560. Administration for spares parts - $8400. These overhead costs are absorbed by products on a machine hour rate of $4.80 per hour, giving an overhead cost per product of: A = $1.20, B = $1.20, C = $ 4.80, D = $7.20 However investigation into the production overhead activities for the period reveals the following totals: Product Number of set-ups Number of material orders A B C D Number of times Materials was handled Number of spare parts Required: 1. To compute an overhead coproduct using activity-based costing, tracing overheads to production units by means of cost drivers. 2. To comment briefly on the differences disclosed between overheads traced by the present system and those traced by activity based costing Sec 1_Ch-05_Activity Based Costing.indd 5.5 1/12/2011 3:51:57 PM

6 5.6 Problems and Solutions: Advanced Management Accounting Solution: Statement of Cost Pool (ABC) Overhead Amount (`) Basis No of Activity Cost per Activity Set-up cost 4,250 No of set-up 17 [ ] 250 Ordering cost 1,920 No of order 10 [ ] 192 Handling cost 7,560 No of times 27 [ ] Administration for spare ports 8,400 No of spare ports 12 [ ] 700 Factory overhead 37,749 Machine hours [ ] Statement of Cost Sheet A (`) B (`) C (`) D (`) (A) Direct material 2,500 25,000 9,600 1,19,000 (B) Direct labour 1,500 15,000 7,200 15,300 (C) Overhead cost: Set , ,000 Material ordering Material handle Spare 700 1,400 3, ,800 Factory ,782 1,816 31,773 Total overhead cost (Total C) 2,335 9,228 3,381 38,035 (a) Overhead/Unit (ABC) (b) Overhead/Unit (Traditional) (a b) difference (1.76) Question 2: A company produces three products A, B and C for which the standard costs and quantities per unit are as follows: Particulars Products A B C Quantity produced 10,000 20,000 30,000 Direct material/p.u.(`) Direct Labour/p.u. (`) Labour hours/p.u Machine hours No. of purchase requisitions 1,200 1,800 2,000 No. of set ups Production overhead split by departments Department 1 = ` 11,00,000 Department 2 = ` 15,00,000 Department 1 is labour intensive and department 2 is machine intensive Total labour hours in Department 1 = 1,83,333 Total machine hours in Department 2 = 5,00,000 Production overhead split by activity Receiving/inspecting ` 14,00,000 Production scheduling/machine set up ` 12,00,000 ` 26,00,000 Number of batches received/ inspected = 5,000 Number of batches for scheduling and set-up = 800 Sec 1_Ch-05_Activity Based Costing.indd 5.6 1/12/2011 3:51:58 PM

7 Activity Based Costing 5.7 Required: (i) Prepare Product Cost Statement under traditional absorption costing and Activity Based costing Method. (ii) Compare the results under two methods. Solution: Statement of Cost Pool (Absorption) Department Cost (`) Basis No. of Activity Cost per Activity I 1,100,000 Labour hours 1,83,333 6 II 15,00,000 Machine hours 5,00,000 3 Statement of Cost (Absorption) A B C Total Material ` 5,00,000 ` 8,00,000 ` 9,00,000 ` 22,00,000 Labour ` 3,00,000 ` 8,00,000 ` 15,00,000 ` 26,00,000 Overhead: Department I ` 1,80,000 (30,000 6) Department II ` 1,20,000 (40,000 3) ` 4,80,000 (6 80,000) ` 2,40,000 (3 80,000) ` 9,00,000 (6 1,50,000) ` 630,000 (2,10,000 3) ` 15,60,000 ` 9,90,000 Total cost 11,00,000 23,20,000 39,30,000 73,50,000 Statement of Comparative Cost Actual Budgeted Effect Department I 11,00,000 15,60,000 4,60,000 (over) Department II 15,00,000 9,90,000 5,10,000 (under) Statement of Cost Pool [ABC] Overhead Amount (`) Basis No. of Activity Cost per Activity Receiving and inspection 14,00,000 Requisition 5,000 [1, , ,000] 280 Setup 12,00,000 Set up 800 [ ] 1,500 Statement of Cost as per ABC A (`) B (`) C (`) Total (`) Material 5,00,000 8,00,000 9,00,000 22,00,000 Labour 3,00,000 8,00,000 15,00,000 26,00,00 Overhead: Receiving 3,36,000 (1, ) Set up cost 3,60,000 (240 1,500) 5,04,000 (1, ) 3,90,000 (260 1,500) 5,60,000 (2, ) 4,50,000 (260 1,500) 14,00,000 12,00,000 Total cost 14,96,000 24,94,000 34,10,000 74,00,000 Statement of Comparative Cost A B C Cost under 14,96,000 24,94,000 34,10,000 Cost under traditional 11,00,000 23,20,000 39,30,000 Absorption costing Difference 3,96,000 1,74,000 (5,20,000) Question 3: The following information provides details of costs, volume and cost drivers for a particular period in respect of ABC Ltd; for product X, Y and Z: Sec 1_Ch-05_Activity Based Costing.indd 5.7 1/12/2011 3:51:58 PM

8 5.8 Problems and Solutions: Advanced Management Accounting Product X Product Y Product Z Total Production and sale unit 30,000 20,000 8,000 Raw material unit (usage) Direct material cost (`) ,38,000 Direct labour hour 1-1/ ,000 Machine hour 1 1/ ,000 Direct labour cost (`) No. of Production Runs No. of deliveries No. of receipts ( 2 7) No. of production orders Overhead costs: Set-up 30,000 Machines 7,60,000 Receiving 4,35,000 Packing 2,50,000 Engineering 3,73,000 ` 18,48,000 The Company operates a just-in-time inventory policy and received each component once per production run. In the past the company has allocated overheads to products on the basis of direct labour hours. However the majority of overheads are related to machine hours rather than direct labour hours. The company has recently redesigned its cost system by recovering overheads using two volume related bases: Machine hours and a material handling overhead rate for recovering overheads of the receiving department. Both the current and the previous cost system reported low profit margins for product X, which is the company s highest-selling product. The management accountant has recently attended a conference on activity-based costing and the overhead costs for the last period have been analyzed by the major activities in order to compute activity-based costs. Required: (a) Compute the product costs using a traditional volume-related costing system based on the assumption that: (1) All overheads are recovered on the basis of direct labour hours ( i.e. the company past product costing system.). (2) The overheads of the receiving department are recovered by a materials handling overhead rate and the remaining overheads are recovered using a machine hour rate (i.e. the company current costing system). (b) Compute product costs using an activity based costing system. Solution: 1 (a) Statement of cost pool [Absorption] Overhead cost = ` 184,8000 Direct labour hours = 88,000 hrs ( , ] Overhead cost per labour hours = 21 per hours Statement of Cost (Absorption) Particulars Product X (`) Y (`) Z (`) Total (`) Material 7,50,000 4,00,000 88,000 12,38,000 Labour 2,40,000 2,40,000 48,000 5,28,000 Overhead 8,40,000 (21 40,000) 8,40,000 (21 40,000) 1,68,000 (21 800) 18,48,000 Total 18,30,000 1,48,0000 3,04,000 36,14,000 Sec 1_Ch-05_Activity Based Costing.indd 5.8 1/12/2011 3:51:59 PM

9 Activity Based Costing (b) Statement of Cost Pool (Absorption] Overhead Amount Basis Quantity Cost/Qty. Receipts 4,35,000 no. of receipt 270 ( ] 1,611.1 Others 14,13,000 machine hours 76,000 (40, , ,000) Statement of Cost (Absorption) X (`) Y (`) Z (`) Total (`) Material 7,50,000 4,00,000 88,000 12,38,000 Labour 2,40,000 2,40,000 48,000 5,28,000 Overhead: Receipts 24,167 56,389 3,54,444 4,35,000 Others 7,43,600 7,31,800 2,97,440 17,72,840 Cost 17,57,767 14,28,189 7,87,884 39,73,840 Statement of Cost Pool (ABC) Overhead Amount (`) Basis No. of Activity Cost per Activity (`) Setup 30,000 No. of set up 30 ( ) 1000 Machine 7,60,000 Machine hour 76,000 (40, , ,600) 10 Receiving 4,35,000 No. of receipt 270 ( ) 1, Packing 4,35,000 No. of receipt 32 ( ) 7,812.5 Engineering 3,73,000 No. of order 50 ( ) 7,460 Statement of Cost (ABC) Particulars X (`) Y (`) Z (`) Total (`) Material 7,50,000 4,00,000 88,000 12,38,000 Labour 2,40,000 2,40,000 48,000 5,28,000 Overhead: ,000 7,000 20,000 30, ,00,000 2,00,000 16,00,000 7,60, ,167 56,389 3,54,444 4,35, ,11,900 74,600 1,86,500 37,000 Cost 15,99,380 10,01,426 10,13,194 36,14,000 Question 4: G Ltd. produces four products. A conventional product costing system is used at present. Now, use an activity based costing (ABC) system is being considered. Details of the four products and relevant information are given below for one period: Product A B C D Output in units Costs per unit ` ` ` ` Direct material Direct labour Machine hours (per unit) The four products are similar and are usually produced in production runs of 20 units and sold in batches of 10 units. The production overhead is currently absorbed by using a machine hour rate, and the total of the production overhead for the period has been analysed as follows: Particulars Amount (`) Machine department costs (Rent dep. and supervision) 20,860 Set-up costs 10,500 Stores receiving 7,200 Inspection/quality control 4,200 Output handling and dispatch 9,240 52,000 Sec 1_Ch-05_Activity Based Costing.indd 5.9 1/12/2011 3:51:59 PM

10 5.10 Problems and Solutions: Advanced Management Accounting The cost drivers to be used for the overhead costs are as listed below: Cost Set up costs Stores receiving Inspection/Quality control Output handling and dispatch Cost Driver Number of production runs Requisitions raised Number of production runs Orders executed The number of requisitions raised on the stores was 20 for each product and the number of orders executed was 84, each order being for a batch of 10 of a product. Required: (a) to calculate the total costs for each product if all overhead costs are absorbed on a machine hour basis; (b) to calculate the total costs for each product, using activity-based costing system; (c) to calculate and list the unit product costs from your figures in (a) and (b) above, to show the differences and to comment briefly on any conclusions which may be drawn which could have pricing and profit implications. Solution: Statement of Cost Pool Overhead Amount Basis No. of Activity Cost per Activity Machine 20,860 Machine hours 5,200 (1, , ,440) 4.01 Setup cost 10,500 No. of set-up 42 ( ) 250 Store 7,200 No. of requisition 80 ( ) 90 Inspection 4,200 No. of purchase order 42 ( ) 100 Output handling and dispatch 9,240 No. of order 84 ( ) 110 Statement of Cost (ABC) Cost A (`) B (`) C (`) D (`) Total (`) Material 19,200 (80 240) 20,000 ( ) 9,600 (160 60) 28,800 ( ) 77,600 Labour 13,440 (240 56) 8,400 (200 42) 4,480 (160 28) 10,080 (240 42) 36,400 Overhead Setup 3,000 (12 250) 2,500 (10 250) 2,000 (8 250) 3,000 (12 250) 10,500 Store 1,800 1,800 1,800 1,800 7,200 Inspection 1,200 1, ,200 4,200 Output handlings and dispatch 2,640 2,200 1,760 2,640 9,240 Machine 7,699 (1, ) 4,812 (1, ) 2,566 ( ) 5,783 (1, ) 20,860 Total cost 48,979 40,712 23,006 53,303 1,66,000 Statement of Cost Pool (Absorption) Overhead = ` 52,000 Machine hours = 5,200 (1, , ,440) Cost per machine hour = 10 Statement of Cost A (`) B (`) C (`) D (`) Total (`) Material 19,200 20,000 9,600 28,800 77,600 Labour 13,440 8,400 4,480 10,080 36, ,200 (1,920 10) 12,000 (1, ) 6,400 (640 10) 14,400 (1,440 10) Cost 51,840 40,400 20,480 53,200 1,66,000 5,200 Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:51:59 PM

11 Activity Based Costing 5.11 Statement of Reconciliation A B C D Total ABC (`) 48,979 40,712 23,006 53,303 1,66,000 Absorption (`) 51,840 40,400 20,480 53,280 1,66,000 Difference (2,861) 312 2, nil The difference of distribution of the overhead occurred due to the following reasons: (i) The ratio of difference activity between the products are different from the ratio of single recovery rate basis. (ii) The product which consumes high volume of activity as compared to machine working hours will absorb high volume of overhead. (The total value of overhead remains same). Question 5: Repak Ltd is a warehousing and distribution stores the products and then re-packs them for distribution as required. There are three customers for whom the service is provided: John Ltd., George Ltd and Paul Ltd. The products from all three customers are similar in nature but of varying degrees of fragility. Basic budget information has been gathered for the year to 30 June and is shown in the following table: Products handled (cubic meter) John Ltd. 30,000 George Ltd. 45,000 Paul Ltd. 25,000 Costs ($000) Packing materials 1,950 (see Note 1) Labour-Basic 350 Overtime 30 Occupancy 500 Administration and management 60 Note 1: Packaging materials are used in re-packing each cubic meter of product for John Ltd, George Ltd and Paul Ltd in the ratio 1:2:3 respectively. This ratio is linked to the relative fragility of the goods for each customer. Note 2: Additional information has been obtained in order to enable unit costs to be prepared for each of the three customers using an activity-based costing approach. The additional information for the year to 30 June has been estimated as follows: 1. Labour and overhead costs have been identified as attributable to each of three work centers receipt and inspection, storage and packing as follows: Cost Allocation Proportions Receipts and inspection Storage Packing % % % Labour-basic Overtime Occupancy Administration and management (iii) Studies have revealed that the fragility of different goods affects the receipts and inspection time needed for the products for each customer. Storage required is related to the average size of the basic incoming product units from each customer. The re-packing of goods for each customers have been evaluated as follows (All Data are provided for each cubic meter for each customer). Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:00 PM

12 5.12 Problems and Solutions: Advanced Management Accounting John Ltd. George Ltd. Paul Ltd. Receipt and inspection (minutes) Storage (square meters) Packing (minutes) Required: A: Calculate the budgeted average cost per cubic mater of packaged products for each customer for each of the following two circumstances: 1. Where only the basic budget information is to be used. 2. Where the additional information enables an activity-based costing Approach to be applied. (ICWA Final 1988) Solution: Statement of Cost Pool (Basis budget) Cost Amount (`) Basis No. of Activity Cost per Activity Packing material 19,50,000 Composite Ratio 1,950 (30:90:75 W.N.) 10,000 Other 9,40,000 Quantity 1,00,000 (30, , ,000) 9.4 Statement of Cost John Ltd. George Ltd. Raul Ltd. Quantity 30,000 45,000 25,000 Packing material (30:90:75) ` 3,00,000 ` 9,00,000 ` 7,50,000 Other cost ` 2,82,000 (9.4 30,000) ` 4,23,000 (9.4 45,000) ` 2,35,000 (9.4 25,000) Total Cost ` 5,82,000 ` 13,23,000 ` 98,5, Department of Overhead Inspection Storage Packing Labour 52,500 35,000 3,63,500 Overtime 15,000 4,500 10,500 Occupancy 1,00,000 3,00,000 1,00,000 Administration & management 24,000 6,000 30,000 Total 1,91,500 3,45,500 4,03,000 Statement of Cost Pool (ABC) Activities Amount (`) Base Inspection 1,91,500 9,30,000 (1,50, ,05, ,75,000) [(5 30,000) + (4,500 9) + (2,500 15)] Storage 3,45,500 27,500 (9, , ,000)] Packing 4,03,000 46,05,000 (1,08, ,25, ,50,0000) Statement of Cost (Additional Production) John George (`) Paul (`) Packing 3,00,000 9,00,000 7,50,000 Receiving & Inspection 30,887 83,395 77,218 Storage 1,13,073 1,69,609 62,818 Packing 94,515 1,77,215 1,31,270 Total 5,38,475 13,30,219 10,21,306 Cost/unit , Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:00 PM

13 Activity Based Costing 5.13 Working Notes: John George Paul Ratio of packing material used Qty. 30,000 45,000 25,000 Relative composite material ratio 30,000 90,000 75,000 Ratio: 30: 90: 75 Question 6: A company manufactures several products of varying levels of designs and models. It uses a single overhead recovery rate based on direct labour hours. The overheads incurred by the company in the first half of the year are as under: Particulars Machine operation expenses 10,12,500 Machine maintenance expenses 1,87,500 Salaries of technical staff 6,37,500 Wages and Salaries of stores staff 2,62,500 During this period, the company-introduced activity based costing system and the following significant activities were identified: Receiving materials and components Set up of machines for production runs Quality inspection. It is also determined that: The machine operation and machine maintenance expenses should be apportioned between stores and produc tion activity in 20:80 ratio. The technical staff salaries should be apportioned between machine maintenance, set up and quality inspection in 30:40:30 ratio. The consumption of activities during the period under review are as under: Direct labour hours worked 40,000 Direct wage rate ` 6 per hour Production set-ups 2,040 Material and component consignments received from suppliers 1,960 Number of quality inspections carried out 1,280 The data relating to two products manufactured by the company during the period are as under: Products Particulars P Q Direct material costs ` 6,000 ` 4,000 Direct labour hours Direct material consignment received Production runs Number of quality inspection done Quantity produced (units) 15,000 5,000 A potential customser has approached the company for the supply of 24,000 units of a component K to be delivered in lots of 3,000 units per quarter. The job will involve as initial design cost of ` 60,000 and the manufacture will involve the following per quarter: Direct material costs ` 12,000 Direct labour hours 300 Production runs 6 Inspection 24 Number of consignment of direct materials to be received 20 The company desired a mark up of 25% on cost. ` Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:00 PM

14 5.14 Problems and Solutions: Advanced Management Accounting Required: 1. Calculate the cost of product P and Q based on the existing system of single overhead recovery rate. 2. Determine the cost of products P and Q using activity based costing system. 3. Compute the sales value per quarter of component K using activity based costing system. (C.A. Final May 2003) SolutionL Statement of Cost Pool Overhead Amount ` Basis No. of Activities Cost per Activity Stores 2,78, ,62,500 No. of receipt 1,960 ( ) Setup 2,55, ,13,000 Inspection 1,280 ( ) Statement of Cost for the Products P and Q P (`) Q (`) Cost: Material 6,000 4,000 Labour 5,760 (960 6) 600 (100 6) Overhead: Production 24,138 ( ) 16,092 ( ) Stores 13, ( ) 14, ( ) Inspection 4,482.3 ( , ( ) Total cost 53, , Overhead = ` 21,00,000 Labour hours = 40,000 ( ) Overhead/hour = (iii) Statement of Cost and Selling Price per Quarter (ABC) Statement of Cost Pool (Absorption) Qty: 3000 (`) Material 12,000 Labour ,800 Avoidable overhead 60,000 Desige x Overhead: Store ( ) Prod. ( ) Quality inspection ( ) 13,128 Total cost 34,428 Profi t (25%) 8,607 Sale value 43,035 Selling Price P.U Working Notes Machine material Set-up Quantity Inspection 30% 40% 30% Salary of technical staff (637500) 19,14,250 2,55,000 1,91, Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:01 PM

15 Activity Based Costing 5.15 Machine mainte6nance and operation 1,91, ,12,500 1,87,500 Total 1,39,125 It can be distributed into store and production in the ratio of 20%: 80% i.e. Store = 2,78,250 Production = 11,13,000 Question 7: Change with Times Ltd. has been manufacturing and selling 4 products A,B,C and D A & B in its production department X and C & D in its production department Y. Product A is a standard product which is produced for one customer, according to the requirements of a long term contract. Products B and C are produced largely in response to orders received from a small number of customers, but limited numbers are produced for inventory. Product D is produced in a range of different colors and is usually produced for stock with orders being dispatched from warehouse, as required. The company is thinking of going to a new product line. In this process, it may even discontinue one of the existing products after ascertaining the individual product costs and its profitability. The following data collected pertain to a six months period: Product Department X Department Y A B Total C D Total Units produced and sold 1, , Selling price (`) Sales revenue (`) 27,500 24,000 51,500 30,000 17,500 47,500 Cost incurred (`) Direct material 10,000 6,400 16,400 9,000 7,500 16,500 Direct labour 3,000 1,600 4,600 3,000 1,000 4,000 21,000 20,500 ` ` Factory Overhead Service department cost Set up 1,370 Purchasing 4,440 Supervision 2,400 Warehouse & dispatch 3,100 Machines 19,800 Power 3,300 23,570 10,840 Selling expenses 7,920 Following the usual practice of allocating all the factory overheads and service departments costs using a blanket rate of 400% of unit direct labour cost and the selling expenses as 8% of unit selling price, the unit profit is worked out as: Product Particulars A B C D Profi t per unit (`) The Cost Accountant of the company considering that using a blanket rate for common cost allocation will always be misleading. As all the operations are predominantly machine operation, arriving at a machine hour rate for each department for allocating the common costs to the products, he finds that each product requires one half an hour of machine time. During the period the machines are used for 1,650 hours 900 in X and 750 in Y. Going into details the Cost Accountant makes a fresh calculation and arrives at the unit profitability of the products under: Product Particulars A B C D Profi t per unit (`) Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:01 PM

16 5.16 Problems and Solutions: Advanced Management Accounting His calculation is based on the following details: Allocation of Common Costs (`) Factory Overheads Total X Y Set up 1, Supervision 2,400 1,200 1,200 Machines 19,800 10,800 9,000 Service Department Cost Purchasing Warehouse and dispatch Power plant 4,440 to be allocated on material costs 3,100 on units produced 3,300 on hours of usage of machines The Management Accountant who has joined the company recently is not at all satisfied with the Cost Accountant s calculation. He feels that an important decision to drop a product cannot be taken based on those figures. He is of the view that a more refined technique is required and when details are available, why not do an activity based costing: With this end in view, he collects the following details: Activity Cost-pools Amount (`) Set up 1,370 Supervision 2,400 Machines 19,800 Order processing 440 Material handling 4,000 Finished goods storage 1,600 Dispatch 1,500 Power 3,300 Selling expenses 7,920 Cost Drivers Particulars A B C D Production batch size (units) Set up time (hrs.) Supervisor s time per period (hrs.) Machine timer per unit (hrs.) Orders processed per period Raw materials inputs per unit Average holding of fi nished goods (unit) No. of deliveries per period Sales staff time per period (hrs.) With the help of these figures, he makes that allocation activity based and produces a profit statement for submission to management. Required: Prepare the product profitability statement based on (a) the blanket rate, (b) the machine hour rate as the Cost Accountant has done, (c) activity based costing as suggested by the Management Accountant. (ICWA Final Dec. 1994) Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:01 PM

17 Activity Based Costing 5.17 Solution: 1. Statement of Profit (Absorption) A (`) B (`) C (`) D (`) Total (`) Material 10,000 6,400 9,000 7,500 32,900 Direct labour 3,000 1,600 3,000 1,000 8,600 Factory overhead (34410) 12,003 6,402 12,003 4,002 34,410 Selling expenses 2,200 1,920 2,400 1,400 7,920 Total cost 27,203 16,322 26,403 13,902 83,830 Selling price 27,500 24,000 30,000 17,500 99,000 Profit ,598 15,170 Note: Under recovery and over recovery exist only when actual base is different from budgeted base. 2. Statement of Profit (Machine Hour Base) A (`) B (`) C (`) D (`) Material 10,000 6,400 9,000 7,500 Labour 3,000 1,600 3,000 1,000 Overhead 10,095 ( ) 8,076 ( ) 10,820 ( ) 5,410 ( ) Setup 2,200 1,920 2,400 1,400 Total cost 25,295 17,996 25,220 15,310 Selling price 27,500 24,000 30,000 17,500 Profit 2,205 6,004 4,780 2,190 Statement of Machine Hours X Y Total Setup ,370 Supervision 1,200 1,200 2,400 Machines 10,800 9,000 19,800 Warehouse 1,691 1,409 3,100 Purchasing 2,213 2,227 4,440 Power plant 1,800 1,500 3,300 Total 18,174 16,236 34,410 Machine hrs ,650 Rate Statement of Cost Pool Overhead Amount Basis No. of Activity ` Set up Set-up 137 ( ) 10 Supervision 2,400 Supervision Hr 240 ( ) 10 Machine 19,800 Machine hour 1,650 ( ) 10 Ordering price 440 Order 110 ( ) 4 Material handling 4,000 Raw mat. input 10,000 ( , ,000) 0.4 Finished goods 1,600 Av. holding 400 ( ) 4 Dispatch 1,500 Delivery 400 ( ) 3.75 Poser 3,300 Machine hrs 1,650 ( ) 2 Selling expenses 7,920 Sale staff 790 ( ) Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:01 PM

18 5.18 Problems and Solutions: Advanced Management Accounting 4. Statement of Profit (ABC) A (`) B (`) C (`) D (`) Material 10,000 6,400 9,000 7,500 Labour 3,000 1,600 3,000 1,000 Overhead: Setup 150 (15 10) 320 (32 10) 100 (10 10) 800 (80 10) Supervision 750 (750 10) 400 (40 10) 750 (75 10) 500 (50 10) Machine 6,000 (500 12) 4,800 (400 12) 6,000 ( ) 3,000 (250 12) Ordering price 40 (4 10) 80 (4 20) 80 (4 20) 240 (4 60) Material handling 800 (2,000.4) 1,600 (4000.4) 800 ( ) 800 ( ) Finished (0 4) 400 (4 100) 400 (4 100) 800 (4 200) Dispatch 37.5 ( ) 150 ( ) ( ) 750 ( ) Power 1, , Selling ( ) 1,604 ( ) 2,005 ( ) 4, ( ) Total cost 22, ,154 23, , Sale value , Profi t 5, ,846 6,677.5 (2,400.24) Question 8: The Excel Ltd. make and sell two products,v4 and V2. Both products are manufactures through two consecutive process-making and packing raw materials is input at the commencement of the making process. The following estimated information is available for the period ending 31 March. Making Packing Conversion cost ($000) ($000) Variable Fixed % of fixed costs are product specific, the remainder are company fixed costs. Fixed Costs will remain unchanged throughout a wide activity range. Product information V4 V2 Production time per unit Making (minutes) Packing (minutes) 6 4 Production sales (units) 5,000 3,000 Selling price per unit($) Direct material per unit (S) (iii) Conversion costs are absorbed by products using estimated time based rates. Required: (a) Using the above information, Calculate unit costs for each product, analysed as relevant. (b) Comment on a management suggestion that the production and sale of one of the product should not proceed in the period ending 31 March. (c) Additional information is gathered for the period ending 31 March has follows: (i) The proportion of product specific conversion costs (variable and fixed) are analysed as follows: Making Process: moulding (60%); trimming (40%) Packing Process; conversion (70%), Packing material (30%) Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:02 PM

19 Activity Based Costing 5.19 (ii) The making process consist of two consecutive activities, mounding and trimming.the moulding variable and product fixed cost conversion costs are incurred in proportion to the temperate required in the moulds. The trimming conversion variable and product fixed costs are incurred in proportion to the consistency of the material. The variable and Product fixed packing process conversion cost are incurred in proportion to the time required for each product. Packing materials (which are part of the variable packing cost) requirements depends on the complexity of packing specified for each product. (iii) An investigation into the effect of the cost drivers on costs has indicated that the proportions in which the total product specific conversion costs are related to V4 and V2 are as follows: V4 V2 Temperature (moulding) 2 1 Material consistency (trimming) 2 5 Time (packing) 3 2 Packing (complexity) 1 3 (iv) Company fixed costs is apportioned to product at an overall average rate per product unit based on the estimated figures. Required: Calculate amended unit costs for each product where activity based costing is used and company fixed costs are apportioned as detailed above. Solution: Statement of Cost Pool Conversion $ Basis No. of Activity Cost per Activity Making: Variable 3,50,000 Time minute 42,000 [( ) )] 8.33 Avoid: Fixed cost 84,000 Time 42,000 2 Unavoidable overhead 1,26,000 Time 42,000 3 Packing: Variable 28,000 Time 42, Fixed unavoidable 84,000 Time 42,000 2 Fixed avoidable 56,000 Time 42, Statement of Cost and Revenue V4 (`) V2 (`) Total (`) Material cost 1,50,000 90,000 2,40,000 Conversion cost: (i) Making; Variable cost 2,18,750 1,31,250 3,50,000 (8.3 5, ) (8.3 15,750) Avoidable fi xed cost 52,500 80,000 2,80,000 (2 26,250) ( ,000) Fixed cost 40,000 16,000 56,000 (30, ) (12, ) Relevant cost 6,61,250 3,48,750 10,10,000 Sale 7,50,000 5,40,000 12,90,000 Benefi t 88,750 1,91,250 2,80,000 Unavoidable fi xed cost: Packing 78,750 47,250 1,26,000 (26,250 3) (3 15,750) Making (2 30,000) 6,00,000 (2 12,000) 24,000 84,000 Profi t 50,000 1,20,000 70,000 Decision: It is not advisable to discontinue the product V4 because unavoidable fixed cost 78, ,000, i.e. 1,38,750 remains constant. Hence, we can say that such fixed cost can be termed as fixed cost. Sec 1_Ch-05_Activity Based Costing.indd /12/2011 3:52:02 PM